Carr’s Call: Krone capitalism is a safe bet

With effectively zero debt, Norway is a relatively safe currency hedge. So are Finland and Sweden.

Summary: Massive money printing programs by many central banks, including in the US and Japan, are signals of economic weakness. But Scandinavian countries are ranking high in terms of fiscal stability, and investing in krones or kronas could provide a perfect hedge against a falling dollar.

Key take-out: Norway, Finland and Sweden effectively have no net public debt, a comparatively small amount of bank debt as a percentage of GDP, and a very small percentage of non-performing loans.

I mentioned briefly on Monday (Japan’s fiscal mirage is a warning sign) that one of the main implications following the Bank of Japan’s ‘bold’ decision to print, was that investors would have to pay a little more attention to wealth protection.

It’s not that its action alone makes it necessary; it just highlighted a simple fact. The economic consensus is ok with governments funding deficit spending by printing money. Indeed, the economic consensus will go out of its way to push the public relations spin associated with it. It’s becoming much more brazen – to the point where calls are being made by respectable people to drop the facade. To come clean and openly admit the truth of what is happening. But even so, these people don’t then suggest it should stop (Alan Kohler sent a link to a good read on the topic, click here).

If the Bank of Japan’s actions weren’t enough, note also commentary from Federal Reserve Chair Ben Bernanke and his number 2, Janet Yellen, who have hinted that quantitative easing (QE) is unlikely to end soon. Yellen has said openly that even if Fed economic targets are met, it may not remove stimulus. Odd, right? I mean why wouldn’t it? Because, as I have long argued and as people are becoming acutely aware – there are no economic targets. Only fiscal ones.

So, citizens and investors are left in a world where:

Some large governments are unwilling or unable to get the public books in order.

Central banks are therefore being relied upon to pick up the slack, lower exchange rates and, in some cases, provide outright funding of large budget deficits. There is no resistance to this from the bulk of economists.

This, in turn, is making governments lazy and disincentivising them to get their books in order.

We have hit circularity effectively, and it won’t end until governments make the decision to rein in their deficit spending, which from point three, isn’t generally happening.

Now this isn’t an invitation or a warning if you prefer to retreat to an ultra-conservative domestic-only portfolio. But it’s because there are great returns to be made abroad, and our currency is strong. As I argued last year, investing abroad should be regarded as a hedge for Australian retail investors.

But, in doing so, we need to be mindful of two things

Diversification, across borders and across asset classes is a must.

1. In the new world order of money printing, political risk is high. It’s one of the biggest risks. At the end of the day, so much depends on random political decision making with regards to fiscal policy and ongoing money printing. I’m not going to pretend I can pick that, especially with the growing acknowledgement that politicians around the globe, and the central banks they command are being less than honest with the citizenry. It’s important to try and diversify this risk away.

2. Store of wealth considerations are more important than ever.

Ideally in constructing your global portfolio, some priority should be given to those countries who stand as a good store of value. That is, countries with low budget deficits, low public and private debt, and ideally a small financial sector/GDP ratio. Why? Because there is a smaller probability of them joining the currency debasement/deficit monetisation rush – and so there is a larger probability that should things deteriorate again your investment will hold its value better.

The table above ranks countries according to the last column, which is the sum of net public debt and domestic bank loans as a percentage of GDP (columns three and five). I include bank loans given the tendency for banking crises to morph into public debt crises in so many countries. A negative number like Norway’s suggests that net-net, there is no debt, while down the bottom you can see that the US and Japan have both large public and financial sector exposure. Which, of course, is why they print money - ditto the UK. For the column titled budget deficit, a positive indicates a budget surplus.

You can see the top three spots are dominated by Scandinavian countries - with no net public debt and a comparatively small amount of bank debt as a percentage of GDP. Add to that a very small percentage of non-performing loans. I’ve only got data to 2011 (an age away), but that showed bad loans as a percentage of the total between 0.5% and 1.5% for each of those Scandinavian economies. For Australia it’s 2.2%, for the US it’s closer to 5%. Japan’s saving grace is that it has a low number of non-performing loans as well. About 2%. Still, that’s about 7% of GDP, which isn’t something Japan can afford.

Now, as I mentioned on Monday, I’m not saying you should steer clear of Japan and the US. It depends on your purpose. Japan is great to trade, and I still think the US is a good investment – just a risky one.

Where store of value considerations become critical is when things go pear-shaped, as they tend to do. Undisciplined central banking has seen about 15 financial crises of varying magnitudes since 1980.Thats one every couple of years, and a big one every three to four years.

The good news is that not every country is in trouble, and table 1 shows you’ve got a widespread of secure places to invest. From small European economies - to the larger ones like Germany. You can then spread into Asia, with South Korea and China offering comparative safety, and then, in South America, Brazil looks to have good accounts. That the Australian dollar is so strong, pretty much at a record or close enough to one, makes it even more attractive. Certainly it’s elevated against the euro, which Finland has adopted, the Norwegian krone and the Swedish krona. Over time you’d expect that to correct, and certainly in a crisis it would. During the GFC all three currencies surged against the dollar.

Note though that all three of those “Skandi” economies are small export-oriented economies (exports account for around 40-50% of GDP), so there is a risk that Sweden and Norway may, at some point, get their central banks to print (like Switzerland). But this would be to a set target – there is limited downside. With the solid metrics they’ve got, people aren’t going to lose faith in their currency. I don’t think anyone could say the same for either the US dollar or yen in a crisis scenario.

In fact, central banks already have. You’ll note over the years the policy of many governments has been to diversify their US dollar holdings into other currencies and, of course gold, (which is a great store of value – buy some). While the US dollar is often seen as the ultimate safe haven – any US-centric crisis such as a terrorist attack or natural disaster could be catastrophic. The Fed has nothing left and nor does the government. That safe haven status is fragile, and investors should take note.

Finally, while Australia actually fares quite well on the above table and certainly there is no need for alarm here, we are currency sensitive. During the GFC the dollar slumped to 62 cents. That’s a big hit to your purchasing power – but you can protect against that by investing abroad.

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